Business liabilities 043-03090020

Section 1121 and section 1121A of the Social Security Act 1991 provide for the deduction of liabilities owed by a person to determine the net assessable value of an asset. This also applies to assets held within a business entity.

Section 1121 provides that if there is a charge or encumbrance over a particular asset of the person, the value of the asset is to be reduced by the value of that charge or encumbrance. Section 1121 also refers to the amount of a charge or encumbrance over a particular asset. This means that, generally, the value of a secured charge or encumbrance must be deducted from the asset against which it is secured.

Generally, all liabilities on the balance sheet of a sole trader or partnership can be deducted from the value of assets (unless it is an exempt asset) owned by the business to determine the assessable value of the business, even if the liabilities are secured over non-business assets as indicated by Guide to the Social Security reference 4.7.1.40. For private trusts and private companies, liabilities secured against assets not owned by the trust or company can be deducted in certain circumstances from the assessable value of the asset of a controller to the extent the asset owner is a controller of the entity.

The most common type of encumbrance over an asset is a mortgage; however, any enforceable liability secured over an asset will meet the requirements of section 1121.

Provision accounts are listed on a business balance sheet to account for future amounts that a business will be liable to pay out to employees, shareholders and/or other parties.

Provisions such as income tax, dividends payable and annual leave are an allowable liability where a business is legally committed to paying out the designated amount at a future date.

As sole traders and partnerships do not have shareholders, they do not pay dividends. As these business structures are not separate from their owners for taxation purposes, they do not have income tax liabilities. Income tax is a personal liability and therefore not related directly to the business. However, sole trader and partnership businesses can have provision accounts in regards to employees, such as accrued annual leave.

There will be no liability allowed where the business has no legal liability to pay out the amounts, for example, long service leave in respect of employees who have not been employed for 7 years, and bad debts.

All assets used in primary production and all liabilities relating to primary production are aggregated (combined) and treated as if they were one primary production asset and one primary production liability. Primary producers are allowed to offset the value of all their primary production liabilities against the value of all their primary production assets regardless of whether they are held in the person's name or within a business structure (for example, they are a full or part controller of a private trust or private company) as designated by section 1121A of the Social Security Act 1991.

Many wheat and barley growers deliver their grain into a national pool controlled by an organisation (for example, Australian Wheat Board, Australian Barley Board) which sells the grain on behalf of the producers.

When the primary producer delivers the grain they can choose to be paid for it via an advance. If they choose this option the Board estimates the value of the grain and advances the grower around 80% of the estimate.

The grower enters into a contract with the Board. This contract is recognised as a loan contract. It is important to remember the Social Security Act 1991 definition of a loan is intended to catch all of a recipient's investments so their asset value may be determined and they may be deemed. The loan between the Grain Board and the primary producer only needs to meet the general legal definition of a loan, to allow it to be assessed as a liability.

For the purpose of assessing a customer's net assets allow the loan advance, paid by the grain growers board, as a liability.

Other reasons for allowing it are:

• under primary production aggregation rules liabilities do not need to be held against a particular asset to be allowed
• the advance liability is balanced by various assets such as cash at bank, stock, plant and equipment which the primary producer has purchased with the advance

Where a liability is secured over an asset exempt from assessment under the Assets Test, (for example, a customer's principal home), the provisions of Section 1121(3) of the Social Security Act 1991 overrides the provisions of Section 1121(1). This means that as the asset against which the encumbrance is secured is exempt from assessment, no deduction for the value of the liability can be made (either against the value of the asset providing security or the value of assets owned by the business).

Assessors need to be mindful of the security provided for business loans when assessing liabilities of a business. Where information indicates the security provided for a business liability may consist of the customer's principal home, further investigation may be needed. The security provided for a business liability can be determined from loan documentation provided by the customer where necessary.

For private trusts and companies, there is also no liability allowed when the liability is secured against assets not owned by the trust or company.

Where a charge or encumbrance is secured over both an assessable asset and an asset exempt from assessment under the Assets Test, section 1121(4) of the Social Security Act 1991 provides the amount of the liability is apportioned between the assessable and exempt assets to calculate the net value of the assessable assets.

The formula for apportionment is:

'amount of the loan x value of the assessable assets / value of all assets providing security'

This will provide the portion of the loan which can be deducted from the value of the assessable assets. The amount of the loans for which the exempt asset provides security cannot be deducted from the value of assets owned by the business and is disregarded when determining the customer's total assessable assets.

Where:

• a customer provides non-business assets as security for business liabilities, and
• the liabilities are deducted from the value of assets owned by the business under the modified application of section 1121, and
• the assessed value of the customer's interest in the business is a deficiency, that is, the business has an excess of liabilities over assets and in the event of the wind-up of the business the customer would not receive any assets and would actually be required to contribute more of his own capital to repay the business loans

the amount of the customer's share of the business deficiency can be offset against the assessable value of the assets providing security for the business borrowings.

An excluded security is the amount of a charge or encumbrance that is:

• a collateral security (fall back security which is provided in addition to the principal security)
• provided for the benefit of a third party

A liability that is an excluded security is not allowed as a deduction against the value of assets providing security. The most common excluded security is a charge or encumbrance over an asset of a customer which relates to a loan given to another person (for example, the customer provides an asset they own as security for a loan made by a financial institution to a person other than the customer or their partner).

Assessors need to be mindful of the purpose for which a loan was obtained when assessing the liabilities of a business. Where information indicates that a loan has been obtained for the benefit of a person other than the customer or their partner further investigation may be needed. Where necessary the purpose for which a loan was obtained can be determined from loan documentation provided by the customer.

Where more than one asset is provided as security by a customer for borrowings from a financial institution, it is unusual for the lending institution to categorise the assets provided as the 'principal' security or 'collateral' security. Usually, all the assets are required by the lender as security for the customer's borrowings. In this situation the total amount of the borrowings would be allowed as a deduction against the assets providing security.

The value of any unsecured liabilities listed on the balance sheet is generally allowed as a deduction from the value of assets owned by the business. The basis for this approach is that it is assumed that such liabilities were obtained for business purposes and they can therefore be taken into account when determining the assessable value of the business. This applies to all unsecured liabilities detailed on a business balance sheet, other than a liability that is an excluded security.

For private trust and private companies, unsecured liabilities, or liabilities secured by a floating charge over all trust and company assets, are generally allowed, unless they are loans from controllers or other third parties. See Assessment of liabilities for trust and companies.